The Disadvantages of High Institutional Ownership Stocks

by Slav Fedorov

Institutional ownership is the percentage of a stock’s float owned by institutions such as mutual funds, pension funds and endowments. Float is the percentage of issued and outstanding shares that can be freely traded, unlike locked-up insider holdings or restricted employee shares. Institutional ownership is usually beneficial to a stock price initially, but very high institutional ownership has several disadvantages.

Initial Benefits of Rising Institutional Ownership

Initial increases in institutional ownership usually benefit a stock. Institutional buying can push up the stock price. Institutions tend to support prices of the stocks they own by stepping up buying whenever a stock price sags, adding stability to the stock. Institutional ownership also lends credibility to the company story. Attracted by the price rise and encouraged by favorable institutional opinions, retail investors start buying as well.

Danger Signs

Institutional ownership can eventually exceed 100 percent of float, which means that, in addition to all the available shares, institutions have also bought up all the borrowed shares from short sellers who are betting that the stock will decline. These high levels of institutional ownership are unsustainable and pose several disadvantages for retail investors.

Limited Upside Potential

Peak institutional ownership often coincides with a stock’s top: the stock price stops advancing when new institutional buying dries up. Institutions may talk up the stock in the media to push its price up further, but after a long advance the stock’s downside potential becomes greater than its upside potential.

Churning

High institutional ownership stocks are often followed by an army of analysts whose job is to generate trading by issuing ratings and recommendations. Analysts sometimes compete with each other: it is not uncommon for one respected analyst to downgrade a stock at the same time that another (equally respected) analyst issues a glowing buy recommendation. These battles of opinion pull investors in opposite directions. The stock begins to churn (make wide swings with little upward progress) on waves of buying and selling.

Sudden Price Drops

Institutions may take weeks or months to accumulate a position in a stock by pacing their purchases. As the stock price advances, more institutions may step up buying. Steady but gradual purchases contribute to the stock’s steady but gradual advance. When institutions decide to sell, they may all rush to the exits at the same time. A glut of stock for sale by institutions can result in sudden and substantial price drops on huge volume that can come unexpectedly.

References

  • “Stan Weinstein’s Secrets From Profiting in Bull and Bear Markets”; Stan Weinstein; 1988
  • “One Up on Wall Street”; Peter Lynch; 2000
  • “How to Make Money in Stocks”; William O’Neil; 2009

Resources

About the Author

Based in San Diego, Slav Fedorov started writing for online publications in 2007, specializing in stock trading. He has worked in financial services for more than 20 years, serving as a banker, financial planner and stockbroker. Now working as a professional trader, Fedorov is also the founder of a stock-picking company.

Photo Credits

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